Introduction
The U.S. central bank considers Bitcoin and other virtual currencies as “convertible” assets, specifically assets that have capital value rather than being considered legal currency. This means that there are tax consequences every time Bitcoin is bought, sold, or traded. This may seem trivial, but it is not. It determines how taxes are applied to Bitcoin – similar to what happens when you own and trade stocks or exchange-traded funds (ETFs) and pay capital gains taxes.
Cryptocurrency Transactions and Tax Implications
The U.S. central bank treats cryptocurrencies – like Bitcoin – as capital assets. It has indicated that virtual currency does not have a status as legal tender in any jurisdiction and is considered “convertible” virtual currency if it has an equivalent value in real currency, or if it is used in exchange for alternatives to real currency. It can be exchanged for another currency, whether real or virtual, and can be traded digitally.
When Do You Have to Pay Taxes on Bitcoin?
Since the U.S. central bank considers Bitcoin a capital asset, it is subject to general tax principles. If you invest in Bitcoin and then sell or trade it at a higher price than what you paid for it, you must pay capital gains taxes. If you own Bitcoin and use it to purchase a good, that is also considered a sale, so you will have to pay capital gains taxes if the Bitcoin you own is worth significantly more than what you paid when you bought it.
Reporting Cryptocurrency on Tax Returns
You must report cryptocurrency transactions on your individual tax returns or IRS Form 1040. If you have engaged in any transaction involving cryptocurrencies, you should check the appropriate box next to the question regarding virtual currency, even if you received any amount for free, including from an air drop or hard fork. Do not check this box if you only conducted transactions between wallets you own yourself.
How Capital Gains Taxes on Bitcoin Work
Assume you bought one Bitcoin for $30,000. Then you sell it for $50,000, giving you a capital gain of $20,000. This would be short-term capital gain if you held the Bitcoin for a year or less and will be taxed as ordinary income based on your tax rate. It is long-term capital gain and taxed at a rate of 0%, 15%, or 20%, depending on your total income, if you have held the Bitcoin for more than a year.
Net Investment Income Tax
You may also find that you are subject to the Net Investment Income Tax, which applies to investment income. The tax is owed if you are a single filer, and if your modified adjusted gross income exceeds $200,000 for the year. The threshold rises to $250,000 for married couples filing jointly and for qualifying widow(er)s. It drops to $125,000 for married couples filing separately.
How to Pay Taxes on Bitcoin
You should establish a system for record-keeping for all your transactions, tracking when you buy Bitcoin and when you dispose of it. Determine your cost basis method and exchange rates. Then record all Bitcoin-related transactions on Schedule D and Form 8949.
What Happens If You Don’t Pay Taxes on Bitcoin?
Bitcoin
It is no different from other sources of income or taxable assets. If you ignore paying taxes on Bitcoin transactions, even if you are unaware that you should do so, you will face penalties. A late fee of 0.5% of the tax amount due will be imposed, up to a maximum of 25% of the unpaid balance.
Tax Tools for Bitcoin
Casual users may want to utilize a reliable Bitcoin wallet provider that includes risk-limiting tools to make the process of buying, selling, and trading Bitcoin safer and easier for the user. On the care side, investors should look for wallet providers or registered investment vehicles that contain security features one might expect from a banking institution. These tools may be helpful when dealing with transactions and when planning for taxes. A web-based Bitcoin program for importing data and calculating profits/losses can also be useful.
Frequently Asked Questions (FAQs)
How can you avoid or reduce taxes on Bitcoin? Ways to reduce cryptocurrency-related taxes are similar to those stock traders use to lower taxes. Holding your positions for the long term to qualify for long-term capital gains is the easiest way to reduce the tax owed. You may also find a retirement account that allows investment in cryptocurrencies, and these tax-advantaged retirement accounts can reduce or eliminate the tax owed on profits.
How to handle cryptocurrency taxes when filing tax returns with TurboTax?
TurboTax recommends using the main tax filing package when you need to include Bitcoin transactions or any other type of cryptocurrency trading. Coinbase customers can import transactions directly into TurboTax Premium.
Can you deduct losses on Bitcoin?
Treat Bitcoin losses the same way you would treat stock losses. You can deduct Bitcoin losses to reduce taxable gains. If you have a net loss, you can deduct up to $3,000 of that loss from your ordinary income.
Source: https://www.thebalancemoney.com/how-bitcoins-are-taxed-3192871
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